The EU, national governments, academics and media are discussing how to rebuild the shattered EMU stability framework, after the Stability and Growth Pact failed to prevent the current crisis. In particular, its weak enforcement mechanism is said to be responsible for the failure.
One proposal for a new stability framework by the European Commission demands more centralisation of fiscal policy. National budget plans would be submitted to and approved by the EU in advance of national legislation. However, this would undermine national sovereignty and would be a further step towards political union.
An alternative framework would see the adoption of very tight fiscal rules (which will become law in Germany from 2011 onwards) for the whole EU. This so called “debt brake” allows structural net borrowing of just 0.35% of GDP. However, the failure of the Maastricht criteria suggests that such rules could be undermined by political pressure. There is also a problem with enforcement.
One recommendation to improve enforcement is to cut EU money for countries that do not stick to the rules. This proposal seems plausible, but it will fail if it is applied to a net paying country. Such a country might offset the cuts with lower contributions to the EU. Further proposals, such as excluding countries from voting in EU legislation or the threat to expel a country from the euro, also have significant drawbacks. Both options conflict with the “European Idea” and might promote nationalism and resistance against the EU, making a break up of the eurozone even more likely.
A better way to avoid a repeat of the current crisis may be to rely on market mechanisms. This implies that a eurozone country can default, either with no restrictions or regulated by an insolvency procedure. However, for market-based restraints on government profligacy to be effective, the EU must make a clear and credible commitment to a no-bailout rule. Regaining credibility may prove difficult in the context of the current multi-billion-euro bailout package.
See also Philip Booth’s article, ”Europe should have allowed Greece to default“, in City AM.